Vietnam Economic Rise Threatened as Middle-Income Trap Looms

By Bloomberg News -
Oct 17, 2012

Vietnamese coffee farmer Le Thi Do
looks up at the five-meter-high (16-foot) ceiling of her six-
bedroom, yellow house and then points to a small, squat building
next door and says: “We used to live in that tiny one.”

Do, 71, has been a barometer of Vietnam’s fortunes since
the French left in 1954. As the country divided, her family fled
to the south, surviving the war, Communist victory and a decade
of hardship that followed by growing vegetables. As the economy
opened in 1986, she switched to coffee and prospered as the rate
of economic growth tripled in five years.

Then, the boom that benefited Do and millions of others
started to slow. Prices of fuel, raw materials and labor soared
as the currency fell. Banks, tied to funding state monopolies,
became reluctant to lend to small businesses. Bad debts rose.
Growth fell below 7 percent in 2008 for the first time in seven
years and could drop to 5.2 percent this year, the government
estimates, the slowest since 1999.

“This year has been very difficult for everyone,” said
Do, who had to raise pay 20 percent for harvest pickers, to
120,000 dong ($5.75) a day. “We need funds for cultivation, but
we have limited access to bank lending. You can get a loan if
you have good connections. Otherwise, it’ll be little or no
money.”

After two decades of development, Vietnam risks falling
into the so-called middle-income trap, where rising earnings and
costs outpace productivity. Government pledges to restructure
banks, curb corruption and reorganize the public sector may take
years, prompting investors to turn to faster-growing rivals in
Southeast Asia such as the Philippines and Indonesia.

’Hard Part’

“Moving through the middle-income bracket is risky and
requires time, political will, perseverance and luck,” said
Jonathan Pincus, an economist in Ho Chi Minh City with the
Harvard Kennedy School’s Vietnam program. “The government needs
to do more to reform the economy and get back to a sustainable
higher rate of growth. You have to do the hard part of building
institutions, building a legal system, enforcing the rules
governing financial institutions.”

Government efforts to curb rising prices and stabilize the
dong slowed growth to 4.7 percent in the first nine months of
2012. Inflation eased to a year-on-year pace of 6.48 percent in
September from more than 23 percent in August 2011. The currency
has risen about 0.9 percent this year against the dollar, after
falling more than 7 percent in 2011.

Stocks Drop

The slowdown has hurt stocks, with the benchmark VN Index (VNINDEX),
Asia’s worst performer in 2011, down 18 percent since its peak
this year on May 8. Yields on five-year government bonds have
fallen 220 basis points since the start of 2012, to 10.35
percent, as inflation decelerated and lenders sought the
relative safety of state-backed debt.

The benchmark VN Index on the Ho Chi Minh City Stock
Exchange fell 0.6 percent to 397.02 at close. The currency has
gained 0.2 percent this month.

Communist Party General Secretary Nguyen Phu Trong
apologized two days ago in a televised address to the nation for
“big mistakes” made by the ruling party, including corruption
and lax oversight of state-owned conglomerates.

“We are trying to speed up the restructuring process of
state companies, aiming to improve their operations and
efficiency,” Deputy Finance Minister Vu Thi Mai, said in an
Oct. 11 interview. She said that as of the end of last month, 53
state enterprises had submitted restructuring plans to reduce
costs and accelerate “the privatization process.”

The country faces a challenge that others have struggled to
overcome. Of 101 middle-income economies in 1960, 13 attained
the World Bank’s high-income bracket by 2008, including Japan,
Hong Kong, Singapore, South Korea and Taiwan, according to a
report this year from the Washington-based development lender.

Income Group

Vietnam joined the World Bank’s lower-middle income bracket
in 2009, with gross national income per capita rising to $1,260
last year, from $110 two decades earlier, according to the
bank’s website. The World Bank classifies lower-middle-income
economies as those with GNI per capita of $1,026 to $4,035 and
upper-middle income from $4,036 to $12,475.

Once Southeast Asia’s fastest-rising destination for
foreign investment, Vietnam risks losing out as other nations in
the region become more attractive to investors.

Pledged foreign direct investment to Vietnam fell 28
percent in the first nine months of 2012 from a year earlier,
the government says. FDI inflows rose more than 31 percent in
Malaysia and Indonesia in 2011 and an estimated 89 percent in
neighboring Myanmar, compared with a 7 percent drop in Vietnam,
according to the United Nations Conference on Trade and
Development.

Myanmar Appetite

“The appetite that a lot of global investors have for
Myanmar in particular now, but also countries like Indonesia and
the Philippines, is based in part on disillusionment about
Vietnam’s performance relative to its promise,” said Mark
Gillin, a director of AIM Capital Management Ltd. in Ho Chi Minh
City. “Given the work ethic and the dynamism of the people
here, Vietnam should be doing far better.”

Moody’s Investors Service on Sept. 28 cut the rating on
Vietnam’s debt for the first time since 2010 to B2, leaving it
on a par with Cambodia and five levels below Indonesia.
Vietnam’s banks have the highest level of bad debt in Southeast
Asia, according to Moody’s.

Even so, the country has come a long way since 1986, when
the government swapped Soviet-style central planning for “Doi
Moi,” or economic renovation -- allowing private business and
granting packages of land to farmers to grow their own crops.

Changed Life

Do and others who began growing coffee were some of the
first to gain. “Coffee changed my life and the lives of many
people here,” said Do in the highland region of Dak Lak.

Production of coffee, introduced in French colonial days,
more than quadrupled in the five years following the start of
Doi Moi, reaching 118,800 metric tons in 1991, according to the
U.S. Department of Agriculture’s Foreign Agricultural Service.

Vietnam is now the world’s largest coffee exporter after
Brazil, shipping 1.6 million tons in the last crop year,
according to the government. The 10 tons a year that Do harvests
from her 2.5-hectare (6-acre) plot earned her enough to build a
160 million dong home, school her nine children and send two of
them on to college.

‘Exciting’ Times

“It was exciting,” said Le Quoc Vinh, 44, chief executive
of publisher Le Media Joint-Stock Co. in Hanoi, who was studying
English at Hanoi University as Doi Moi began. “It was the first
time we really felt we had to compete to improve our lives.”

Vinh publishes five consumer titles, including Vietnam’s
best-selling fashion magazine, Dep, or Beauty, which features 14
top Vietnamese models on its latest cover and advertises Louis
Vuitton bags and Shiseido cosmetics. Like Do, he prospered
during the boom and now drives a Mercedes, and his eldest son is
studying in Australia. He said many clients have cash-flow
challenges and advertisers are struggling to sell their
products.

“If you’re not inside the system, you don’t really have a
chance,” said Vinh. “If you’re not friends with that bank,
it’s almost impossible to borrow. If you’re not friends with
that state-owned company, it’s difficult to win a contract.”

Even with the restraints on business, the commercial hub of
Ho Chi Minh City, formerly called Saigon, shows the changes of
the boom years. In the new terminal at Tan Son Nhat airport, the
scene of intense fighting in the last days of the Vietnam War,
travelers eat at Burger King and Domino’s Pizza. Downtown, the
yellow, Roman-columned building that once housed South Vietnam’s
parliament is now the Ho Chi Minh City Stock Exchange.

No Honking

Foot passengers who five years ago paid 500 dong to take
the antiquated ferry across the Saigon River to District Two,
now walk over Thu Thiem bridge, while cars speed through a
Japanese-financed tunnel, where the frenetic lane-changing and
horn-honking of the city’s streets are banned.

The carved images of gods of the 18th-century, incense-
filled Giac Vien pagoda rub shoulders with the water slides of
Dam Sen water and amusement park, where the increasingly chubby
children of the new middle class view the changing city from a
Ferris wheel.

“I grew up in a difficult time, where everybody around me
had to work very hard, and the money we could make was not very
much,” said Vinh, the publisher, who as a four-year-old hid
with his parents in a small room in their house as U.S. bombs
rained down. “Now, some families have become rich while other
families are not so rich. There is a gap between neighbors.”

Bank Ties

To sustain Vietnam’s growth trajectory and narrow that gap,
the government has pledged to address the inefficiency that has
grown through ties between banks and the state companies that
receive much of their lending.

State enterprises’ non-core investments, such as property
and stocks, account for as much as 12 percent of their
registered capital, Deputy State Auditor Le Minh Khai said in
July. Vietnam Electricity, known as EVN, and Vietnam National
Shipping Lines, or Vinalines, have “large” investments in non-
core businesses, Khai said. Government-controlled companies
account for about a third of the total market value of the VN
Index, according to data compiled by Bloomberg.

EVN’s Chairman Dao Van Hung was fired in February after the
power company lost 11.5 trillion dong over two years, according
to the government’s website. The utility has been building a
93,351 square meter twin-tower headquarters since 2007 that the
company said may be completed next year. Behind a solitary guard
under a parasol, the empty structure with a rubble-strewn
entrance looms above the city’s old quarter.

Making Arrest

Police arrested Duong Chi Dung on Sept. 4 after a three-
month manhunt for the former chairman of Vinalines, part of an
investigation into contracts that the government says raised the
cost of a floating dock by 72 percent in 2007.

The restructuring of state monopolies is inextricably
linked with a clean-up of the banks that funded them.

The government promised to complete the restructuring of
weak banks by the end of next year. Prime Minister Nguyen Tan Dung approved a plan in March that would allow the finance
ministry to buy collateralized non-performing assets from
commercial banks to strengthen their balance sheets.

The central bank chief, Nguyen Van Binh, said in April the
level of bad debt at some lenders may be “much higher” than
reported. The bank estimated non-performing loans were 8.6
percent at the end of March.

Political Pressure

Government-run banks are often subject to political
pressure to lend to favored state-owned enterprises, according
to a January policy paper from the Harvard Kennedy School.

Binh has vowed to crack down on violations by groups with
vested interests who are working against the banking reforms. In
a televised interview posted on the government’s website on Oct.
7, he said some lenders are controlled by only one or two
individuals or a small group of shareholders, and 70 percent to
90 percent of outstanding loans at some banks are made to
“serve those shareholders.”

“They may manipulate operations at one bank and affect the
whole system,” Binh said. “Group interests are the biggest
obstacle in the entire Vietnam banking system restructuring
process.”

Police arrested Asia Commercial Bank (ACB) founder Nguyen Duc Kien, one of the country’s wealthiest men, on Aug. 20 for
alleged economic mismanagement, sparking a run on the bank.

Capital Needed

The financial system needs an injection of 250 trillion
dong to 300 trillion dong, according to a 298-page report
published in September by the National Assembly’s Economic
Committee and compiled by an advisory group.

Vietnam is still attractive to some external investors,
especially as China is getting more expensive, said Pincus at
the Harvard Kennedy School. Intel Corp. (INTC) opened a $1 billion
assembly and testing plant in 2010 in Saigon Hi-Tech Park that
Rick Howarth, general manager of Intel Products Vietnam, said
last month was “ramping up smoothly.”

In Jabil Circuit Inc. (JBL)’s factory nearby, a young Vietnamese
technician carefully solders parts for an electronic point-of-
sale terminal, checking her work against a computer screen above
her station. As many as 20 percent of Jabil’s 1,350 local
workers had no previous computer experience, said Kesavan
Swaminathan, general director of the Vietnam unit of St.
Petersburg, Florida-based Jabil.

“We teach them here,” said Swaminathan at the plant,
which operates 24 hours a day, seven days a week. “Some of them
initially freaked out, but as they are being guided and coached,
they realize it’s an additional skill they are learning.”

Bus 611

The technology park has a new, four-lane avenue flyover
above the clogged main road of Le Van Viet Street, along which
bus 611 carries riders for 4,000 dong -- without air-
conditioning, and in a haze of motorbike fumes and tropical heat
-- across a bridge that’s only wide enough for a single truck.

Symbols of Vietnam’s boom years in the capital Hanoi are
juxtaposed with reminders of how far the country still has to go
to even out the benefits of economic gain.

Between the Bentleys and Range Rovers in the square by
Hanoi’s yellow-and-cream opera house, street vendors carry food
and wares on bamboo poles on their shoulders. Across the square,
burnished in gilt, a Gucci outlet sells handbags for twice the
average annual wage, while a cleaner in a French maid’s pinafore
mops the marble floor.

“Business has been very difficult this year,” said Nguyen
Thi Nhung, 38, who sells lingerie and hair accessories from a
mobile metal cart. “People do not want to spend on frivolous
items like pretty bras.”

Pushing Cart

In a conical hat and face mask to shield her from the
traffic fumes, she pushes her cart for miles each day till after
10 p.m. to pay for her children’s schooling.

“My dream is that my kids will one day work in an office
like that,” she said, pointing to a 10-story glass office
block, that houses foreign firms and a private gym on the top
floor. “I want them to have an easier life than I do.”

Vietnam isn’t the only country in the region facing a
slowdown as Europe’s debt crisis erodes trade. Growth in
developing East Asia, which excludes Japan and India, will
probably ease to an 11-year low of 7.2 percent, from 8.3 percent
last year, the Washington-based World Bank said in an Oct. 8
report.

Still, Vietnam is only at the bottom rung of the middle-
income ladder, and must first catch more-advanced neighbors,
such as Thailand, where GNI per capita last year was $4,420.

Bite Bullet

“Will Vietnam grow from $1,500 to $5,000 per capita income
uninterrupted or will it have to go through the boom and bust
cycles?” said Deepak Mishra, World Bank lead economist for
Vietnam in Hanoi. “If it wants a smooth transition to an upper-
middle-income status, it will have to bite the bullet and
credibly restructure its economy.”

In her yellow house in Dak Lak, Do retains the optimism
that characterizes many Vietnamese who’ve seen their lives
improve since 1986.

“The situation will gradually get better in the next few
years when the global economies recover and the government sorts
out problems like the bank lending,” she said. “I’ve seen so
many things here improve in the past few decades.”